The Role of Human Capital in Economic Development.pdf

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I. ROLE OF HUMAN CAPITAL IN ECONOMICDEVELOPMENT: SOME MYTHS AND REALITIES*

A. Background

The world today is very different from the one whichexperienced the two world wars. During the second half of thetwentieth century, considerable advancements in science andtechnology, along with the establishment of broadly-basedgovernments and strengthening of institutions, have led to significantsocio-economic progress and improvement in the lives of a largenumber of people in many countries. However, there are still manyothers among us who are lagging behind. The current reality in theAsian region is the existence of significant differences in the state ofeconomic development among countries. For instance, when GNP percapita income is taken as an indicator of economic development (seefigure I.1), the figures for both Asian least developed countries andSouth Asian developing countries such

* This paper was prepared by Mr M. Aynul Hasan, Chief, LeastDeveloped Countries Section, Development Research and Policy

Analysis Division, ESCAP.

Figure I.1. GNP per capita income (in US$), 1999

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

USdollars

India Pakistan Malaysia

South Asian DCs

East Asian DCs

Bangladesh Bhutan Cambodia Lao

People's

Democratic

Republic

Nepal Republic

of Korea

Thailand


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In light of the above, the pertinent question is: what factors led

to this exceptional economic development for some countries (i.e., EastAsian developing countries) in the last three decades in terms ofincreasing their GNP per capita income by as much as over 65 timesfor the Republic of Korea, 13 times for Thailand and about 10 times forMalaysia while, during the same period for Asian least developedcountries and South Asian developing countries, only a meagreincrease of 2 to a little over 5 times took place? Obviously, the factorscould be numerous, ranging from social to cultural, from economicpolicies to institution development, geographic location to opportune

time. In this paper, however, rather than focussing on all these factorstogether, which of course is beyond the scope of this study, only thesocio-economic factors, particularly the human capital dimensions, arebriefly investigated across the group of countries to establish thepossible role and linkage of human capital with economicdevelopment.

B. Human capital and economic development

Theoretical perspective: What exactly is the role of humancapital and other social variables in economic growth anddevelopment of an economy? In the traditional neoclassical growthmodels developed by Robert Solow and Trevor Swan in the 1950s, theoutput of an economy grows in response to larger inputs of capitaland labour (all physical inputs). Non-economic variables such ashuman capital or human health variables have no function in thesemodels. Furthermore, the economy under such a model conforms to

the law of diminishing returns to scale. With these assumptions, theneoclassical growth models afford some implications to the economy;particularly that as the capital stock increases, growth of the economyslows down, and in order to keep the economy growing it mustcapitalize from incessant infusions of technological progress. It is wellknown that this type of mechanism in the neoclassical growth model isneither inherent nor does it strive to explain much; in economiclexicon, this simply means that the technological progress isexogenous to the system. Yet the reality is quite contrary to that,

particularly for the East Asian developing economies mentioned


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earlier, where the economies kept growing for well over three decades.This implies that it is not only technology which is the main drivingforce accountable for maintaining such high growth performance in

these economies, but that there are other factors which are outside therealm of neoclassical growth model.

Addressing the above issues, in the mid 1980s, a new paradigmwas developed in the literature, mostly due to the Paul Romer (1986),which is now commonly known as endogenous growth models. Bybroadening the concept of capital to include human capital, the newendogenous growth model argues that the law of diminishing-returns-to-scale phenomenon may not be true as is the case for East Asian

economies. In simple terms, what this means is that if the firm whichinvests in capital also employs educated and skilled workers who arealso healthy, then not only will the labour be productive but it willalso be able to use the capital and technology more efficiently. Thiswill lead to a so called Hicks neutral shift in the production functionand thus there can be increasing rather than decreasing returns toinvestments. In other words, technology and human capital are bothendogenous to the system.

Indeed, the advent of endogenous growth models withhuman capital (providing externalities) have certainly enhanced theunderstanding of the mysteries of rapid and long sustainable highgrowth performances of East Asian economies. However, in order toestablish the point whether healthy human capital was one of theimportant factors in explaining the economic development for theAsian countries in the region, it will be useful to analyze the actualdata on these variables across the countries considered earlier.Although there are many variables that can represent human capital

and health conditions of the people of a nation, to keep the analysissimple while, at the same time, capturing the basic broad thrust ofthese two variables, this paper will focus on total literacy rate and lifeexpectancy at birth.

Empirical evidence: In inspecting the total literacy rate data forvarious groups of Asian countries in figure I.3, it is intriguing to notethat even in the 1960s when most of these countries were at similarstages of economic development, East Asian developing countries

were far ahead of both Asian least developed countries and South


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Asian developing countries. In fact, the total literacy rates for EastAsian developing countries in the 1960s were as high as 71 per cent forthe Republic of Korea, 68 per cent for Thailand and even Malaysia had

a rate of over 50 per cent. On the other hand, in case of all Asian leastdeveloped countries and South Asian developing countries, the totalliteracy rates were as low as only 9 per cent for Nepal and 15 per centfor Pakistan with Cambodia having a rate of 38 per cent. After threedecades, while Asian least developed countries and South Asiandeveloping countries have somewhat ameliorated their human capital,the total literacy rates are still far below 50 per cent particularly, incase of Bangladesh, Nepal and Pakistan as shown in figure I.3. Duringthe same period, however, the East Asian developing countries have

more or less achieved the formidable task of educating most of theirpeople. As a result, in the late 1990s, the total literacy rate of theRepublic of Korea has reached 98 per cent and Malaysia managed toachieve a rate of about 90 per cent.

Analyzing the health variable measured in terms of lifeexpectancy at birth across the three groups of countries in the Asianregion, like the literacy rate, again a similar sort of pattern is evidentamong these countries. For instance, in the 1960s, all Asian least

developed countries and South Asian developing countries had alife


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Sources:World Bank, World Development Report 1982 (Oxford University Press, 1982);

UNESCO, Statistical Yearbook 1999 (UNESCO Publishing & Bernan Press, 1999).

expectancy at birth below 45 years with Bhutan and Nepal having afigure of even much less than 40 years as shown in figure I.4. On theother hand, during the same period, the East Asian developingcountries had a life expectancy at birth well over 50 years with theRepublic of Korea having a figure over 54 years followed by 53 yearsfor Malaysia and 51 years for Thailand. In the late 1990s, although theAsian least developed countries and South Asian developing countries

enhanced their life expectancy to a level of over 60 years at least in thecase of Bangladesh, Bhutan, India and Pakistan, nevertheless, EastAsian developing countries record, in this context, is far morepoignant as shown in figure I.4. In the case of both Malaysia and theRepublic of Korea, the life expectancy rate is now in the order of over72 years with Thailand reaching a figure of 69 years.

Figure I. 3. Total literacy rate, 1960 and 1998

0

10

20

30

40

50

60

70

80

90

100

Percentage

1960 1998

Bangladesh India Malaysia

Asian LDCs

South Asian DCs

East Asian DCs

Cambodia Lao

People's

Democratic

Republic

Nepal Pakistan Republic

of Korea

Thailand


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Sources:World Bank, World Development Report 1984 (Oxford University Press, 1984);

and World Development Indicators 2001 (Washington DC, 2001).

What can one infer from the discussions so far? First of all,the empirical data overwhelmingly incarnate that, in the past threedecades, the three groups of Asian countries considered in this paperstarted with a similar state of economic development but now, in thelate 1990s, there is a marked difference among them on account oftheir per capita incomes. The East Asian developing countries are nowwell beyond the reach of Asian least developed countries as well asSouth Asian developing countries in terms of economic development.Secondly, although in terms of per capita income all these groups of

countries were quite comparable in the 1960s, nevertheless, in thecontext of human capital and health sector development, there werehuge differences among them; East Asian developing countries were,by far, ahead of both Asian least developed countries as well as SouthAsian developing countries even in the 1960s. In the 1990s, most EastAsian developing countries population were literate while Asian leastdeveloped countries and South Asian developing countries still have along way to go. Thirdly, based on the facts presented earlier, it isevident that the onslaught of East Asian developing countries rapid

economic progress in the 1980s occurred along with their reasonably

Figure I. 4. Life expectancy at birth, 1960 and 1999

0

10

20

30

40

50

60

70

80

90

Year

1960 1999

Bangladesh India Malaysia

Asian LDCs South Asian DCs

East Asian DCs

Bhutan Cambodia Lao

People's

Democratic

Republic

Nepal Pakistan Republic

of Korea

Thailand


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well developed and healthy human capital endowment which startedto take momentum in the 1960s or even earlier.

It is the view of the author that, for human capital to spawn aperceptible impact on economic development, a nation needs to have aminimum captious mass of at least 70 per cent or more literatepopulation. What this means is that if an overwhelmingly largenumber of people in a country are literate, even with simple basiceducation as being able to read newspapers, this may open up theminds of the masses, possibly make them more enlightened workersand perhaps institute some element of discipline in them. These are,of course, some of the essential prerequisites for a large organized

production to run efficiently and for leading to rapid growth.Through mass literacy, better prepared healthy workers andconducive investment friendly government policies, East Asiandeveloping countries seem to have been able to furnish those essentialelements of rapid growth at the very early stages of theirdevelopment. And, therefore, at the dawn of globalization in the early1980s, East Asian developing countries were befittingly prepared toattract large sums of foreign investments thus accomplishing rapideconomic progress. On the other hand, during the same period,

unfortunately both Asian least developed countries and South Asiandeveloping countries were neither primed in terms of human capitalendowments at large nor were their government investment policiesresponsive enough to allure foreign investors in sizeable quantities totrigger rapid economic growth. Thus, in a mere two decades, bothAsian least developed countries and South Asian developing countrieslagged far behind the East Asian developing countries to the extentthat any catching up in the near future by the former groups ofcountries to the level of the latter countries would be a very

challenging onus.

What led to the divergence in human capital among nations?As demonstrated above, a well developed human capital base of anation played an important role in economic development and, on thiscount, East Asian developing countries were far ahead of Asian leastdeveloped countries as well as South Asian developing countries evenat the early stages of economic development. A germane public policyquestion, in this context, is how the East Asian developing countries

managed to delude such a well developed human capital base as


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compared to Asian least developed countries and South Asiandeveloping countries even when the per capita incomes for all thesecountries were rather similar as shown earlier. In other words, for all

practical purposes, in the 1960s, all these groups of nations could becontemplated as equally rich or equally poor, yet in terms of humancapital development they were distant apart from each other. What ledto this significant divergence in the human capital developmentamong these groups of countries? This study argues that it is thedirection of a nations priorities and commitments measured in termsof actual resources devoted towards the education sector that led tosuch differences in human capital among the groups of countries. Thisview is perspicuously supported by the data on per capita government

investments in education as well as in health for various groups ofcountries in the region as shown in table I.1.Inspection of table I.1 clearly reveals that in the 1970s (or

earlier), governments in Asian least developed countries and SouthAsian developing countries were spending only a scanty amount of 40cents to $ 1.60 on a per capita basis on education. At the same time,however, under comparable economic conditions, East Asiandeveloping countries governments were investing much larger sumsof money on education on a per capita basis; anywhere between $ 9.10

by the Republic of Korea to as high as $ 16.40 in case of Malaysia. Asfor the health sector, although the per capita public investments gapsin the 1970s (or earlier) were somewhat narrower, an East Asiandeveloping country like Malaysia was still spending over $ 5.5 perperson as opposed to only 12 cents by Pakistan as shown in table I.1.Now in the new millennium, however, the disparities in per capitaexpenditure on both education and health between Asian leastdeveloped countries and South Asian developing countries and EastAsian developing countries are staggering to the extent that for

education on a per capita basis, the Republic of Korea is spending over26 times that of India and Pakistan and as high as 95 times ofCambodia.

The preceding discussions based on empirical data presented intable I.1, unequivocally support the view that East Asian developingcountries were far more committed and gave high priorities toeducation and health sectors as compared to Asian least developedcountries and South Asian developing countries by way of incessantly

investing large sums money in these sectors on a per capita basis even


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in the early stages of economic development. The impact of thoseinvestments were directly ruminated in terms of high literacy ratesand markedly improved years of life expectancy at birth thus leading

to higher per capita incomes and economic development.

C. Gestation period for human capital investments

Given the acceptation of human capital investments towardseconomic development, a pertinent question is whether the time takenor the gestation period of such investments to proliferate intendedimpact in terms of literate skilled workers is comparable to that of

physical infrastructure investments such as roads, highways andhydroelectric dams. It needs to be underscored that, while thephysical infrastructure investments may ordinarily take a long time tobe completed, however, the impact period for human capitalinvestments could be even longer if it is to forge results. Not only that,while it may even be possible to abbreviate the gestation period ofphysical infrastructure investment by apportioning moreresources through

Table I.1. Per capita expenditures on education and health sectors (in US$), 1970 and 2000

Countries Education Health

1970

(or earlier)

2000

(or latest year)

1970

(or earlier)

2000

(or latest year)

Asian least developed countries

Bangladesh

CambodiaNepal

1.2

1.40.4

6.8

3.95.8

0.5

2.30.3

3.2

2.62.0

South Asian developing countries

IndiaPakistan

1.58

0.42

13.77

14.24

0.35

0.12

2.43

4.27

East Asian developing countries

Malaysia

Republic of Korea

Thailand

16.4

9.1

11.0

226.4

371.4

88.1

5.5

0.7

2.0

61.2

17.8

25.8


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Source: Calculations based on World Bank, World Development Report 1982 (Oxford University

Press, 1982) and World Development Indicators 2001 (Washington DC, 2001). Asian

Development Bank, Key Indicators of Developing Asian and Pacific Countries (Oxford University

Press) various issues.

borrowing or foreign aid, the same cannot be said for human capital.Notwithstanding of the size and pace of human capital investments, itwill necessitate a fixed number of years (say five years for a primaryhigh school or eight years for secondary education) to shape ageneration of educated and skilled labour force.

Another important distinction between physical infrastructureand human capital investments is that the former type of investmentcustomarily requires a one-time capital expenditures while the lattercategory enjoins investments on an interminable basis. For instance,once a hydroelectric dam project is completed, it is expected togenerate electricity for a long time without entailing future heavycapital expenses. On the other hand, to mould a generation ofeducated workers will entail investments in human capital on anincessant basis. Thus, the return of the social sector investment is a

long term continuous proposition and, therefore, its affiliation witheconomic growth and development should be delved and analyzedwithin a framework which has a longer perspective. This propositionis also empirically substantiated by the author for Pakistan in twoother earlier studies (Pasha, Hasan et al, 1996a, 1996b). Based on alarge, over 200 equations dynamic econometric model of Pakistan, thefindings of these studies insinuated that a shift in the investmentpriority to social development (i.e., education sector) would entailenduring positive impact on economic growth but with long lags of

about eight years. The results of the studies further suggested that, inthe short to medium term, the impact of human capital investment oneconomic growth for the country may not be noticeable; however,after the critical time period of eight years the economic growth for thecountry will be substantial and long-lasting.

D. Concluding remarks


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towards public policy? First of all, the study empirically found outthat in the past three decades, among other things, the nations

Asian region with broad based healthy human capital (such as EastAsian developing countries) grew faster than the ones (such as Asian

where these elements were missing. Thus, the empirical results in thiscorroborated the premise that there is an important link

between healthy human capital and rapid economic development of.

Secondly, the study also found that, under similar economic

predicaments with comparable per ccountries (such as East Asian developing countries) were investing farmore in human capital and health sectors on a per capita basis than the

Asian developing countries). This result substantiated the point thatis the commitment and priority of a nation rather than othereconomic factors aloneas compared to Asian least developed countries and South Asiandevelo

even when they were all equally opulent or equally penurious.

Thirdly, it is important to acknowledge the fact that there is adistinction between investments in human capital versus physical

finding of the study, in this context, upholds the view that, while it ispossible to cut down the gestation period of physical infrastructure

e same outcome, however,may not be possible for human capital investment.

physical infrastructure investment, human capital developmentinvestment is a long term as well as continuous proposition

ic policy are verysimple and unpretentious. In the 1960s, most countries in the Asian

were remarkably analogous in terms of their economicdevelopment. However, at the dawn of the new millennium, although

uth Asian developingcountries have made some economic progress, these countries are still


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attributed to their earlier copious investments made in human capital.What policy options and choices are available to the Asian leastdeveloped countries and South Asian developing countries under the

prevailing circumstances to improve economic development and tocatch up with the East Asian developing countries? It is the view ofthe author that they will have to adopt similar policy options as theEast Asian developing countries did in the 1960s - that is to deeplycommit and heavily invest in human capital development. This studyhas shown that there is no shortcut procurable in terms of educatingthe masses of a nation and in the event these countries demonstrateany laxity in building up a broad human capital base sooner than laterthis is likely to be a recipe of postponing the impending quagmire to a

future date.


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REFERENCES

Hafiz Pasha, M. Aynul Hasan, Aisha Ghaus and M. Ajaz Rasheed,

Pakistan, Pakistan Development Review -579.

______, 1996b. An integrated planning model aexpenditure on social development: the case of Pakistan,ESCAP , BoxV.1, New York, pp. 144 145.

Romer, Paul, 1986. Increasing returns and long- Journalof Political Economy, Vol. 94, pp. 1002-1037.

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